<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE SECOND QUARTER ENDED JUNE 30, 1998
COMMISSION FILE NUMBER 0-22202
PAIRGAIN TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0282809
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation of organization)
14402 FRANKLIN AVENUE, TUSTIN, CALIFORNIA 92780-7013
(Address of principal executive offices)
(714) 832-9922
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports ), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
------- -------
THERE WERE 70,385,708 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR VALUE $.0005
PER SHARE, OUTSTANDING ON JUNE 30, 1998.
<PAGE> 2
PAIRGAIN TECHNOLOGIES, INC.
INDEX
<TABLE>
<CAPTION>
PAGE
----------
<S> <C>
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
at June 30, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Income
for the quarters and six months ended June 30, 1998 and 1997 4
Condensed Consolidated Statements of Comprehensive Income
for the quarters and six months ended June 30, 1998 and 1997 5
Condensed Consolidated Statements of Cash Flows
for the six months ended June 30, 1998 and 1997 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 17
Part II. Other Information
Item 1. Legal Proceedings 23
Item 2. Changes in Securities 23
Item 3. Defaults upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
</TABLE>
2
<PAGE> 3
PART I: ITEM 1
FINANCIAL INFORMATION
PAIRGAIN TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
----------------- ----------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 119,414 $ 111,602
Short-term investments (Note 4) 78,917 64,983
Accounts receivable 33,351 35,429
Inventories (Note 5) 40,607 30,538
Other current assets and deferred taxes 20,313 19,074
--------- ---------
TOTAL CURRENT ASSETS 292,602 261,626
Property and equipment, net (Note 6) 16,440 17,423
Long-term investment (Note 7) 3,000 3,000
Other assets 383 370
--------- ---------
TOTAL ASSETS $ 312,425 $ 282,419
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 7,660 $ 8,527
Accrued expenses (Note 9) 22,963 21,702
Accrued income taxes 14,205 16,673
--------- ---------
TOTAL CURRENT LIABILITIES 44,828 46,902
COMMITMENTS AND CONTINGENCIES
Stockholders' equity:
Preferred stock, $.001 par value:
Authorized shares - 2,000,000
Issued and outstanding shares - None -- --
Common stock, $.0005 par value:
Authorized shares - 175,000,000
Issued and outstanding shares - 70,385,708 and 69,023,713
at June 30, 1998 and December 31, 1997, respectively 35 34
Additional paid-in capital 154,298 146,277
Deferred compensation (123) (161)
Accumulated other comprehensive income (Note 10) 188 82
Retained earnings 113,199 89,285
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 267,597 235,517
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 312,425 $ 282,419
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE> 4
PAIRGAIN TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
REVENUES $ 73,416 $ 66,369 $146,035 $137,118
Cost of revenues 36,133 33,583 71,867 69,363
-------- -------- -------- --------
Gross profit 37,283 32,786 74,168 67,755
-------- -------- -------- --------
Operating expenses:
Research and development 9,822 7,535 19,358 13,693
Selling and marketing 7,584 5,941 14,789 10,741
General and administrative 3,471 2,469 6,554 4,902
Merger expenses -- -- -- 2,642
-------- -------- -------- --------
Total operating expenses 20,877 15,945 40,701 31,978
-------- -------- -------- --------
INCOME FROM OPERATIONS 16,406 16,841 33,467 35,777
Interest and other income, net 2,100 1,586 4,192 2,835
-------- -------- -------- --------
Income before income taxes 18,506 18,427 37,659 38,612
Provision for income taxes (Note 1) 6,754 6,707 13,745 15,518
-------- -------- -------- --------
NET INCOME $ 11,752 $ 11,720 $ 23,914 $ 23,094
======== ======== ======== ========
Per Share Data (Note 1):
Earnings per share
Basic $ 0.17 $ 0.17 $ 0.34 $ 0.34
======== ======== ======== ========
Diluted $ 0.16 $ 0.16 $ 0.32 $ 0.31
======== ======== ======== ========
Average shares outstanding
Basic 70,120 67,839 69,832 67,352
======== ======== ======== ========
Diluted 75,111 74,736 75,157 75,138
======== ======== ======== ========
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE> 5
PAIRGAIN TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income $11,752 $11,720 $23,914 $23,094
------- ------- ------- -------
Other comprehensive income, net of
tax:
Unrealized gains on securities:
Unrealized holding gains arising during 71 86 106 99
period
Less: reclassification adjustment for
gains included in net income -- -- -- --
------- ------- ------- -------
Net unrealized gains 71 86 106 99
------- ------- ------- -------
Other comprehensive income (Note 10) 71 86 106 99
------- ------- ------- -------
Comprehensive income $11,823 $11,806 $24,020 $23,193
======= ======= ======= =======
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE> 6
PAIRGAIN TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
-------------------------
1998 1997
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 23,914 $ 23,094
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 4,845 3,350
Loss on sale of equipment 73 --
Change in operating assets and liabilities:
Accounts receivable 2,078 (6,196)
Inventories (10,069) 2,825
Other current assets (1,301) 569
Other assets 65 (22)
Accounts payable (867) 2,139
Accrued expenses 1,320 2,626
Income taxes 1,973 15,061
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 22,031 43,446
--------- ---------
Cash flows from investing activities:
Net (purchases of ) proceeds from short-term investments (14,441) 1,161
Purchases of property and equipment (3,359) (7,203)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (17,800) (6,042)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock 3,581 5,034
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 3,581 5,034
--------- ---------
Increase in cash and cash equivalents 7,812 42,438
Cash and cash equivalents at beginning of period 111,602 48,416
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 119,414 $ 90,854
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid $ 14,297 $ 1,387
========= =========
Income tax refunds $ 2,508 $ 950
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
6
<PAGE> 7
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES
PairGain Technologies, Inc., ("PairGain" or the "Company") designs,
manufactures, markets and supports a comprehensive line of digital
telecommunications products that allow telecommunications carriers and private
network owners to more efficiently provide high-speed digital services to end
users over the large infrastructure of unconditioned copper wires. These
services enable high-speed data transmission for applications such as T1/E1,
high-speed Internet access, telecommuting, wide area networking and video
conferencing.
On February 27, 1997, the Company acquired Avidia Systems, Inc.
("Avidia"). (See Note 2) Avidia is engaged in the business of developing,
manufacturing and marketing xDSL aggregation products and network switching
products based on Asynchronous Transfer Mode ("ATM") technology.
INTERIM PERIOD ACCOUNTING POLICIES
In the opinion of the Company's management, the accompanying unaudited
condensed consolidated financial statements contain all normal recurring
adjustments necessary to present fairly the financial position as of June 30,
1998, and consolidated results of operations, comprehensive income and cash
flows for the three and six months ended June 30, 1998 and June 30, 1997.
Results of operations for the three and six months ended June 30, 1998, are not
necessarily indicative of results to be expected for the full year ending
December 31, 1998.
Although the Company believes that the disclosures in the accompanying
financial statements are adequate to make the information presented not
misleading, certain information and footnote information normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission (the "SEC"), and these financial
statements should be read in conjunction with the Company's audited consolidated
financial statements included in the Company's Form 10-K/A for the year ended
December 31, 1997.
PRINCIPLES OF CONSOLIDATION
The condensed consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant intercompany
transactions have been eliminated in consolidation.
7
<PAGE> 8
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
TRANSLATION OF FOREIGN CURRENCIES
Foreign subsidiary financial statements are translated into U.S. dollars
in accordance with Statement of Financial Accounting Standards ("SFAS") No. 52,
"Foreign Currency Translations." The functional currency of the Company's
Canadian and Swiss subsidiaries is the U.S. dollar. Therefore, translation gains
and losses are included in results of operations. Transaction and translation
gains and losses were not significant in the six months ended June 30, 1998 or
year ended December 31, 1997.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the
current year presentation.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Pursuant to SFAS No. 107, "Disclosures about Fair Value of Financial
Instruments," the Company is required to estimate the fair value of all
financial instruments included on its balance sheet at June 30, 1998 and
December 31, 1997. The Company considers the carrying value of such amounts in
the financial statements to approximate their fair value due to the relatively
short period of time between origination of the instruments and their expected
realization or the overall immateriality of the amounts.
COMPREHENSIVE INCOME
Pursuant to SFAS No. 130, "Reporting Comprehensive Income," the Company
has included Consolidated Statements of Comprehensive Income for the three and
six month periods ended June 30, 1998 and 1997. See Note 10 for further
discussion.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities at
the date of purchase of less than three months to be cash equivalents.
8
<PAGE> 9
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
SHORT-TERM INVESTMENTS
Short-term investments are accounted for in accordance with SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities."
Management determines the appropriate classification of such securities at the
time of purchase and reevaluates such classification as of each balance sheet
date. Based on its intent, the Company's investments are classified as
available-for-sale and are carried at fair value, with unrealized holding gains
and losses, net of tax, included in accumulated other comprehensive income in
stockholders' equity. The investments are adjusted for amortization of premiums
and discounts to maturity and such amortization is included in interest income.
Realized gains and losses and declines in value judged to be other than
temporary are determined based on the specific identification method and are
reported in the consolidated statements of income.
INVENTORIES
Inventories are stated at lower of cost (determined on a first-in,
first-out basis) or market. The Company maintains allowances for estimated
obsolete and excess inventories based upon projected sales levels.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost. The Company provides for
depreciation and amortization using the straight-line method. The estimated
useful life of equipment is three to five years. Leasehold improvements are
amortized over the lesser of five years or the life of the lease.
WARRANTY RESERVE
The Company accrues warranty reserves, which are charged against cost of
revenues, based upon historical rates and estimated future costs.
CONTINGENCIES
The Company is involved from time to time in litigation incidental to
its business. The Company believes that none of its pending litigation matters,
individually or in the aggregate, will have a material adverse effect on its
financial position or results of operations.
REVENUE RECOGNITION
Revenue from product sales is recognized at the time of shipment.
Provision is made currently for estimated product returns. Revenue from royalty
income and technology licensing fees is recognized when earned.
9
<PAGE> 10
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred.
INCOME TAXES
Income taxes are provided at the rate expected to be in effect for the
entire year.
PER SHARE INFORMATION
Pursuant to SFAS No. 128, "Earnings Per Share," ("SFAS No. 128"), the
Company provides dual presentation of "Basic" and "Diluted" earnings per share
("EPS"). SFAS No. 128 replaced "Primary" and "Fully diluted" EPS under
Accounting Principles Board ("APB") Opinion No. 15.
Basic EPS excludes dilution from common stock equivalents and is
computed by dividing income available to common stockholders by the weighted
average number of common shares outstanding for the period. Diluted EPS reflects
the potential dilution from common stock equivalents, similar to fully diluted
EPS, but uses only the average stock price during the period as part of the
computation.
EPS for the quarter and six months ended June 30, 1997 have been
restated to reflect the adoption of SFAS No. 128.
The following table reconciles the weighted average shares outstanding
for basic and diluted earnings per share for the periods presented.
10
<PAGE> 11
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
1998 1997 1998 1997
-------- -------- -------- --------
Net income $ 11,752 $ 11,720 $ 23,914 $ 23,094
======== ======== ======== ========
<S> <C> <C> <C> <C>
Basic earnings per common share:
Weighted average of common shares outstanding 70,120 67,839 69,832 67,352
======== ======== ======== ========
Basic earnings per common share $ 0.17 $ 0.17 $ 0.34 $ 0.34
======== ======== ======== ========
Diluted earnings per common share:
Weighted average of common shares outstanding 70,120 67,839 69,832 67,352
Weighted average of common share equivalents:
Weighted average warrants outstanding 24 40 32 84
Weighted average options outstanding 11,058 10,024 11,113 11,176
Anti-dilutive options (2,561) -- (2,182) --
Shares assumed to be repurchased using the
treasury stock method (2,704) (2,040) (2,763) (2,230)
Shares assumed to be repurchased to reflect
the effects of tax benefits (826) (1,127) (875) (1,244)
-------- -------- -------- --------
Weighted average number of common and common
equivalent shares 75,111 74,736 75,157 75,138
======== ======== ======== ========
Diluted earnings per common share $ 0.16 $ 0.16 $ 0.32 $ 0.31
======== ======== ======== ========
</TABLE>
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information," ("SFAS No. 131"). This statement establishes standards for the way
companies report information about operating segments in annual financial
statements. It also establishes standards for related disclosure about products
and services, geographic areas and major customers. The disclosures prescribed
by SFAS No. 131 are effective for calendar 1998, however, the standard need not
be applied to interim financial statements in the initial year of its
application. The Company is still evaluating the impact of adopting SFAS No. 131
and plans to implement this new standard in its 1998 year-end financial
statements.
11
<PAGE> 12
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," ("SFAS No. 132"). This
statement revises and standardizes employers' disclosure requirements about
pension and other postretirement benefit plans, requires additional information
on changes in the benefit obligations and fair values of plan assets that will
facilitate financial analysis and eliminates certain disclosures that are not
longer useful. The Company does not maintain an employee pension plan or any
other postretirement benefit plans.
STATEMENT OF CASH FLOWS
The Company recorded noncash tax benefits from exercises of common stock
options aggregating approximately $4.4 million and $12.9 million during the six
months ended June 30, 1998 and 1997, respectively.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees using the
intrinsic value method in accordance with APB Opinion No. 25, "Accounting for
Stock Issued to Employees."
2. ACQUISITION OF AVIDIA
On February 27, 1997, the Company acquired Avidia pursuant to an
Agreement and Plan of Reorganization (the "Merger Agreement") among Avidia and
others, with Avidia surviving as a wholly-owned subsidiary of the Company (the
"Acquisition") in a transaction accounted for as a pooling-of-interests.
Pursuant to the Merger Agreement, the Company issued approximately 2,235,637
shares of PairGain Common Stock to Avidia stockholders in exchange for all
outstanding Avidia Common Stock and Preferred Stock and vested warrants to
purchase Avidia Common Stock. In addition, outstanding options and unvested
warrants to purchase Avidia Common Stock were exchanged for options and warrants
to purchase approximately 232,521 and 131,168 shares, respectively of the
Company's Common Stock.
3. CONCENTRATION OF CREDIT RISK, MAJOR CUSTOMERS AND PRODUCTS
The Company markets its products principally to telephone companies in
the United States and Canada. Credit is extended based on an evaluation of the
customer's financial condition and collateral is not required. Credit losses are
provided for in the financial statements and historically have been minimal. A
decision by a significant customer to substantially decrease or delay purchases
from the Company or the Company's inability to collect receivables from
customers could have a material adverse effect on the Company's financial
condition and results of operations.
12
<PAGE> 13
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
Revenues from HiGain products represented approximately 61% and 72% of
the Company's total revenues for the six months ended June 30, 1998 and 1997,
respectively. A decline in demand for HiGain products, whether as a result of
competition, deployment of fiber cable, technological change or otherwise, could
have a material adverse effect on the Company's operating results.
Export sales represented 21% and 23% of product revenue during the three
months ended June 30, 1998 and 1997, respectively. During the first half of 1998
and 1997, export sales represented 20% and 19% of product revenues,
respectively. Product sales by geographical region are summarized as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
1998 1997 1998 1997
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
United States $ 56,686 $ 51,418 $113,056 $110,967
Canada 5,534 7,215 11,611 14,281
Other international 9,096 7,720 17,345 11,712
-------- -------- -------- --------
Total product revenues 71,316 66,353 142,012 136,960
Royalty income and technology licensing fees 2,100 16 4,023 158
-------- -------- -------- --------
Total revenues $ 73,416 $ 66,369 $146,035 $137,118
======== ======== ======== ========
</TABLE>
4. SHORT-TERM INVESTMENTS
Short-term investments as of June 30, 1998 and December 31, 1997 are
summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
------- --------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
JUNE 30, 1998
Municipal bonds $76,460 $ 167 $ -- $76,627
Other short-term investments 2,161 129 -- 2,290
------- ------- --------- -------
$78,621 $ 296 $ -- $78,917
======= ======= ========= =======
DECEMBER 31, 1997
Municipal bonds $62,695 $ 140 $ -- $62,835
Other short-term investments 2,160 -- (12) 2,148
------- ------- --------- -------
$64,855 $ 140 $ (12) $64,983
======= ======= ========= =======
</TABLE>
13
<PAGE> 14
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
There were no realized gains or losses on short-term investments during
the six months ended June 30, 1998 and 1997. Unrealized holding gains on
short-term investments, net of tax, included in accumulated other comprehensive
income in stockholders' equity at June 30, 1998 and December 31, 1997 were
$188,000 and $82,000, respectively.
5. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
-------- -----------
(IN THOUSANDS)
<S> <C> <C>
Finished goods $21,007 $14,119
Work in process 5,866 6,982
Raw materials 13,734 9,437
------- -------
$40,607 $30,538
======= =======
</TABLE>
6. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
-------- ------------
(IN THOUSANDS)
<S> <C> <C>
Machinery and equipment $ 31,488 $ 28,555
Leasehold improvements 3,594 3,444
-------- --------
35,082 31,999
Less accumulated depreciation and amortization (18,642) (14,576)
-------- --------
$ 16,440 $ 17,423
======== ========
</TABLE>
7. LONG-TERM INVESTMENT
In June 1996, the Company made a minority investment in E/O Networks of
Hayward, California ("E/O"). E/O supplies low-density fiber optic access
equipment to public carriers both domestically and internationally. The Company
purchased approximately 545,000 shares of E/O's Series D Preferred Stock for an
aggregate of $3.0 million. This investment is accounted for using the cost
method.
14
<PAGE> 15
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
8. BANK LINE OF CREDIT
The Company maintains an unsecured line of credit with a bank. The line
allows maximum borrowings of $5,000,000, including the issuance of letters of
credit and foreign exchange contracts. The line bears interest at the prime rate
(8.5% at June 30, 1998). At June 30, 1998 and December 31, 1997, the Company had
no outstanding borrowings under this line of credit. The debt agreement
specifies certain financial and other covenants. The Company was in compliance
with the financial and other covenants at June 30, 1998 and December 31, 1997.
The agreement expires May 1, 1999.
9. ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
-------- ------------
(IN THOUSANDS)
<S> <C> <C>
Accrued compensation and related expenses $ 8,863 $ 8,836
Accrued warranty 9,458 9,161
Other accrued expenses 4,642 3,705
------- -------
$22,963 $21,702
======= =======
</TABLE>
10. OTHER COMPREHENSIVE INCOME AND ACCUMULATED OTHER COMPREHENSIVE INCOME
The gross amount and related tax effects allocated to each component of
other comprehensive income consist of:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
---------------------------------------------------------------------------
1998 1997
------------------------------------ ------------------------------------
GROSS AMOUNT INCOME TAX NET AMOUNT GROSS AMOUNT INCOME TAX NET AMOUNT
------------ ---------- ---------- ------------ ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Unrealized holding gains
arising during period $112 $ 41 $ 71 $143 $ 57 $ 86
Less: reclassification
adjustment for gains
realized in net income -- -- -- -- -- --
---- ---- ---- ---- ---- ----
Net unrealized gains 112 41 71 143 57 86
---- ---- ---- ---- ---- ----
Other comprehensive income $112 $ 41 $ 71 $143 $ 57 $ 86
==== ==== ==== ==== ==== ====
</TABLE>
15
<PAGE> 16
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
--------------------------------------------------------------------------------
1998 1997
-------------------------------------- --------------------------------------
GROSS AMOUNT INCOME TAX NET AMOUNT GROSS AMOUNT INCOME TAX NET AMOUNT
------------ ---------- ---------- ------------ ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Unrealized holding gains
arising during period $168 $ 62 $106 $165 $ 66 $ 99
Less: reclassification
adjustment for gains
realized in net income -- -- -- -- -- --
---- ---- ---- ---- ---- ----
Net unrealized gains 168 62 106 165 66 99
---- ---- ---- ---- ---- ----
Other comprehensive income $168 $ 62 $106 $165 $ 66 $ 99
==== ==== ==== ==== ==== ====
</TABLE>
The sole component of accumulated other comprehensive income at June 30,
1998 and December 31, 1997 was unrealized gains on securities.
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
Balance at December 31, 1997 $ 82
Other comprehensive income for the six months ended June 30, 1998 106
----
Balance at June 30, 1998 $188
====
</TABLE>
16
<PAGE> 17
PART I: ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
PAIRGAIN TECHNOLOGIES, INC.
Except for the historical information contained herein, the matters
discussed in this Form 10-Q are forward-looking statements which involve
risk and uncertainties. The following discussion should be read in
conjunction with the audited consolidated financial statements and related
notes in the Company's Form 10-K/A for the year ended December 31, 1997, as
well as the section entitled "Risk Factors" in Item 1 of the 1997 Form
10-K/A. The Company's future operating results may be affected by various
trends and factors which are beyond the Company's control and could cause
actual results to differ materially from those in the forward-looking
statements. These include, among other factors, economic, competitive,
governmental and technological factors affecting the Company's operations,
markets, products, services and prices. Accordingly, past results and trends
should not be used by investors to anticipate future results or trends.
RESULTS OF OPERATIONS (quarter and six months ended June 30, 1998, compared to
quarter and six months ended June 30, 1997)
REVENUES
Revenues for the quarter ended June 30, 1998 increased to $73.4 million,
compared to $66.4 million in the corresponding 1997 quarter. Product revenues
increased $5.0 million, or 7%, over the prior year quarter. Unit sales of the
Company's T1/E1 access products, which includes the HiGain product line,
increased 35% over the second quarter of 1997. However, due to declines in
average selling prices as a result of significant price competition, T1/E1
access revenues remained flat compared to the corresponding 1997 quarter.
Revenues from sales of the Company's PG-Flex, PG-Plus and megabit access product
lines were nearly five times the 1997 levels. Sales of the Company's PG-2
products were lower than the 1997 levels, as a result of competition and
customers switching to PG-Plus products. Sales of the Company's Campus product
also declined when compared to the prior year period. The Company had revenue
from royalty income and technology licensing fees of $2.1 million during the
second quarter of 1998, the result of an agreement entered into during the first
quarter of 1998 for licensing of the Company's Falcon chip. Royalty income in
the second quarter of 1997 was $16,000.
Revenues for the six months ended June 30, 1998, increased to $146.0
million compared to $137.1 million for the first six months in 1997. Product
revenues increased $5.1 million, or 4%. During the first six months of 1998,
unit sales volume of the Company's T1/E1 access products increased 32% over the
same period in 1997, but significant declines in average selling prices resulted
in lower T1/E1 revenues in 1998. Sales of the Company's PG-Flex, PG-Plus and
megabit access product lines in the first half of 1998 were more than five times
the sales in the same 1997 period. Sales of the Company's PG-2 and Campus
products declined from levels sold during the first half of 1997. Royalty income
and technology licensing fees for the first six months of 1998 was $4.0 million,
17
<PAGE> 18
primarily the result of the Falcon chip licensing agreement entered into during
the first quarter of 1998. Royalty income in the first half of 1997 was
$158,000.
GROSS PROFIT
Gross profit represents total revenues for a period, including royalty
income and technology licensing fees, less the cost of revenues for such period.
Cost of revenues represents primarily product costs, together with associated
overhead expenditures and provisions for inventory and related reserves. Gross
profit increased $4.5 million or 14% and $6.4 million or 9% for the quarter and
six months ended June 30, 1998, respectively, as compared with the prior year
periods.
As a percentage of revenues, gross profit was 51% for the quarter and
six month period ended June 30, 1998 compared to 49% for the quarter and six
month period in 1997. The higher gross profit percentage resulted from an
increase in royalty income and technology licensing fees. The Company has been
able to maintain its gross product margin despite decreases in average selling
prices of its products due to continuing cost reduction through engineering
design changes, reduced prices for components, increased manufacturing
efficiencies and increase in volume.
The Company expects that increased competition will continue to place
downward pressure on the average selling prices of its existing products.
Declining average selling prices may adversely affect gross product margins on
the Company's existing products if the Company is unable to fully offset such
price reductions by reductions in the Company's per unit cost. The Company's
ability to mitigate future declines in its gross product margin will depend in
part upon its ability to introduce and sell new products with higher gross
product margins and further reduce its per unit costs.
OPERATING EXPENSES
Operating expenses increased $4.9 million, or 31%, for the three months
ended June 30, 1998 as compared with the same period in the prior year. For the
six month period, operating expenses, excluding merger expenses, increased $11.4
million, or 39%. Costs relating to the addition of personnel represented
approximately 46% and 49%, respectively, of these increases. As a percentage of
revenues, operating expenses, excluding merger expenses, were 28% in each of the
three and six month periods in 1998 compared to 24% and 21% in the respective
1997 periods.
Research and development expense increased $2.3 million or 30% and $5.7
million or 41%, respectively, for the quarter and six months ended June 30,
1998, as compared with the same periods in the prior year. These increases were
primarily due to the addition of personnel including those specific to
technology development and costs for developmental tools, supplies, equipment
and other costs specific to achieving new product approval. Research and
development expense as a percentage of revenues was 13% in both the 1998 quarter
and six month period, respectively, compared to 11% and 10% in the corresponding
1997 periods.
Selling and marketing expense increased $1.6 million or 28% and $4.0
million or 38%, respectively, for the quarter and six months ended June 30,
1998, as compared with the same periods in the prior year. Additional sales and
marketing support personnel, and trade show, sales promotion and travel costs
primarily accounted for the increase in expenditures. Selling and marketing
expense as a
18
<PAGE> 19
percentage of revenues was 10% in the 1998 quarter and six month period,
respectively, compared to 9% and 8% in the corresponding 1997 periods.
General and administrative expense increased $1.0 million or 41% and
$1.7 million or 34%, respectively, for the quarter and six months ended June 30,
1998, as compared with the same periods in the prior year. Incremental payroll
expenses due to the addition of information management personnel and increases
in expenditures for computer software and legal fees represented the majority of
these increases. As a percentage of revenues, general and administrative expense
was 5% and 4% in the 1998 quarter and six month period, respectively, compared
to 4% in the corresponding 1997 periods.
MERGER EXPENSES
Expenses related to the acquisition of Avidia aggregating approximately
$2.6 million were charged against the operations of the Company in the quarter
ended March 31, 1997. These expenses consisted of $1.8 million in investment
banking fees, $588,000 in legal fees, $120,000 in accounting fees and $121,000
in other expenses.
INCOME FROM OPERATIONS
As a result of the above, income from operations for the quarter ended
June 30, 1998 decreased slightly to $16.4 million, compared to $16.8 million for
the 1997 quarter. Income from operations for the six months ended June 30, 1998
decreased 6% to $33.5 million, compared to $35.8 million for the first half of
1997. As a percentage of revenues, income from operations was 22% and 23%,
respectively, for the quarter and six month period in 1998, compared to 25% for
the 1997 quarter and 26% for the first six months of 1997. Excluding merger
expenses, income from operations for the first six months of 1997 was 28% of
revenues.
INTEREST AND OTHER INCOME, NET
Net interest income increased to $2.1 million and $4.2 million for the
three and six months ended June 30, 1998, respectively, from $1.6 million and
$2.8 million in the corresponding 1997 periods. These increases resulted
primarily from higher average cash levels available for investment and slightly
higher investment rates of return. There was no interest expense during the
first half of 1998 or 1997.
PROVISION FOR INCOME TAXES
The provision for income taxes for the three and six months ended June
30, 1998, was $6.8 million and $13.7 million, respectively, compared to $6.7
million and $15.5 million, for the three and six months ended June 30, 1997. The
Company's estimated effective tax rate for the second quarter and the first six
months of 1998 was 37%. The estimated effective tax rate in the second quarter
of 1997 was 36%. The Company's effective tax rate for the first six months in
1997 was 40%, due to the non-deductibility of merger expenses. Without the
effect of the merger expenses, the Company's estimated effective tax rate was
38% for the first half of 1997.
19
<PAGE> 20
NET INCOME AND EARNINGS PER SHARE
Net income for the three months ended June 30, 1998 was $11.8 million
compared to $11.7 million in the corresponding 1997 quarter. Net income for the
first six months of 1998 was $23.9 million, compared to $23.1 million in the
first half of 1997. Excluding merger expenses, net income for the first half of
1997 was $25.7 million.
Basic earnings per share for the three and six months ended June 30,
1998 were $0.17 per share and $0.34 per share, respectively, compared to $0.17
per share and $0.34 per share for the quarter and first half of 1997. Excluding
merger expenses, basic earnings per share for the first half of 1997 were $0.38
per share.
The weighted average number of common shares outstanding was 70.1
million and 67.8 million for the three months ended June 30, 1998 and 1997,
respectively. The weighted average number of common shares outstanding was 69.8
million and 67.4 million for the first half of 1998 and 1997, respectively. This
increase in common shares was attributable to the exercise of stock options and
warrants and the issuance of shares under the Employee Stock Purchase Plan.
Dilutive earnings per share, which take into account the dilutive
effects of common stock options and warrants, were $0.16 per share and $0.32 per
share, respectively, for the three and six months ended June 30, 1998, compared
to $0.16 per share and $0.31 per share for the quarter and first half of 1997.
Excluding merger expenses, diliutive earnings per share for the first half of
1997 were $0.34 per share. The weighted average number of common and common
equivalent shares outstanding was 75.1 million and 74.7 million for the three
months ended June 30, 1998 and 1997, respectively. The weighted average number
of common and common equivalent shares outstanding was 75.2 million and 75.1
million for the first half of 1998 and 1997, respectively.
20
<PAGE> 21
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1998, the Company had $198.3 million in cash, cash
equivalents and short-term investments and $247.8 million in working capital.
These figures represent an increase of $21.7 million in cash, cash equivalents
and short-term investments and $33.1 million in working capital over the year
ended December 31, 1997. These increases were primarily attributable to cash
generated from operations of $22.0 million and $3.6 million from the exercise of
stock options, offset by capital expenditures of approximately $3.4 million.
Accounts receivable decreased to $33.4 million at June 30, 1998, compared to
$35.4 million at December 31, 1997. Accounts receivable days outstanding were 42
at June 30, 1998 compared to 43 at December 31, 1997. Gross inventories
increased $7.9 million to $58.5 million at June 30, 1998, compared to $50.6
million at December 31, 1997. Reserves for inventory obsolescence, excess
quantities, cost reductions and test and evaluation inventories decreased to
$17.9 million at June 30, 1998 compared to $20.1 million at December 1997 as a
portion of surplus, scrap and returned material inventories were written off.
Accounts payable and other current liabilities were $44.8 million at June 30,
1998 compared to $46.9 million at December 31, 1997.
Capital expenditures during the six month period ended June 30, 1998
were $3.4 million, consisting primarily of purchases of computer equipment and
software, machinery and test equipment. Capital expenditures in the first half
of 1997 aggregated approximately $7.2 million, primarily related to expenditures
for computer equipment, test equipment, initial payments for a manufacturing and
material handling system and improvements to the Company's new engineering and
production facility adjacent to its Tustin headquarters facility.
The Company believes that its current cash, cash equivalents and
short-term investment balances and internally generated cash flow will be
sufficient to meet its working capital and capital expenditure requirements
through 1998. To the extent that the Company's existing resources, together with
future earnings, are insufficient to fund the Company's future activities, the
Company may need to raise additional funds through public or private financings.
Use of Proceeds From Registered Securities
The effective date of the Company's first registration statement (the
"Registration Statement") filed on Form S-1 (Registration No. 33-66680) under
the Securities Act of 1993, as amended, was September 13, 1993. The class of
securities registered was Common Stock. The offering commenced on September 15,
1993 and all securities were sold in the offering. The managing underwriters for
the offering were Lehman Brothers, Inc. and Hambrecht & Quist, Inc.
Pursuant to the Registration Statement, the Company sold 4,140,000
shares of its Common Stock for an aggregate offering price of $58.0 million, and
certain selling shareholders sold 632,500 shares of the Common Stock of the
Company for an aggregate offering price of $8.9 million.
The Company incurred expenses of $4.7 million of which $4.1 million
represented underwriting discounts and commissions and $573,000 represented
other expenses. All such expenses were direct or indirect payments to others.
The net offering proceeds to the Company after total expenses was $53.3 million.
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<PAGE> 22
Of the net proceeds from the offering, $5.3 million was used to pay off
indebtedness in 1993 and $48.0 million has been invested in short-term
investments. In 1995, the Company realized a $15.8 million unauthorized trading
loss. See Notes 15 and 16 of Notes to Consolidated Financial Statements
contained in the Company's Form 10-K/A for the year ended December 31, 1997.
The use of the proceeds from the offering does not represent a material
change in the use of the proceeds described in the prospectus which is part of
the Registration Statement.
YEAR 2000 ISSUE
The following discussion should be read in conjunction with the section
entitled "Year 2000 Issue" in Item 7 of the Company's Annual Report on Form
10-K/A for the year ended December 31, 1997.
Many of the world's computer systems currently record years in a
two-digit format. Such computer systems will be unable to properly interpret
dates beyond the year 1999, which could lead to business disruptions in the U.S.
and internationally (the "Year 2000" issue). The potential costs and
uncertainties associated with the Year 2000 issue will depend on a number of
factors, including software, hardware and the nature of the industry in which a
company operates. Additionally, companies must coordinate with other entities
with which they electronically interact, such as customers, creditors and
borrowers.
The Company will utilize both internal and external resources to
reprogram, or replace, and test its software for Year 2000 modifications. The
total cost to the Company of these Year 2000 issue activities has not been, and
is not anticipated to be, material to its financial position or results of
operations in any given year. Costs incurred related to the Year 2000 issue are
being funded through operating cash flows.
The above was based upon management's best estimates, which were derived
utilizing numerous assumptions of future events, including the continued
availability of certain resources, third party modification plans and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are not
limited to, the availability and cost of personnel trained in this area, the
ability to locate and correct all relevant computer codes, the nature and amount
of programming required to upgrade or replace each of the affected programs, the
rate and magnitude of related labor and consulting costs and the success of the
Company's external customers and suppliers in addressing the Year 2000 issue.
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<PAGE> 23
PART II. OTHER INFORMATION
PAIRGAIN TECHNOLOGIES, INC.
Item 1. Legal Proceedings
As previously reported in Item 3. Legal Proceedings in the Company's
Annual Report on Form 10-K/A for the year ended December 31, 1997, the
U.S. Attorney's office and the Securities and Exchange Commission have
been investigating S. Jay Goldinger and Capital Insight, Inc. in
connection with their 1995 loss of nearly $100 million of their clients'
funds, including $15.8 million of PairGain's funds. The U.S. Attorney
and the SEC are also investigating whether PairGain and some of its past
and present officers and employees engaged in any wrongdoing with
respect to PairGain's investment of its excess cash with Capital
Insight, the disclosure of such investments and the disclosure of losses
incurred. There were no changes to these matters during the period ended
June 30, 1998.
See Item 1. Legal Proceedings in the Company's Quarterly Report on Form
10-Q for the first quarter ended March 31, 1998 for disclosure regarding
Harris Corporation's suit against the Company and others. There were no
changes to these matters during the period ended June 30, 1998.
The Company is involved from time to time in litigation incidental to
its business. The Company believes that none of its pending litigation
matters, individually or in the aggregate, will have a material adverse
effect on its financial position or results of operations.
Item 2. Changes in Securities
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
At the Annual Meeting of Stockholders held on June 24, 1998, the
stockholders:
o ratified the appointment of one individual to serve on the Board
of Directors until the 2000 Annual Meeting;
o elected two directors to serve on the Board of Directors until
the 2001 Annual Meeting;
o approved a series of amendments to the 1993 Stock Option/Stock
Issuance Plan including an automatic share increase feature and
changes related to recent amendments to Securities and Exchange
Commission Rule 16b-3; and
o approved the selection of Deloitte & Touche LLP as the Company's
independent auditor for the fiscal year ending December 1998.
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<PAGE> 24
Results of the voting are shown below:
TO RATIFY THE APPOINTMENT OF THE FOLLOWING DIRECTOR TO SERVE FOR A TERM
OF TWO YEARS:
<TABLE>
<CAPTION>
Votes For Votes Withheld
---------- --------------
<S> <C> <C>
Howard G. Bubb 44,807,254 1,190,901
</TABLE>
TO ELECT THE FOLLOWING DIRECTORS TO SERVE FOR A TERM OF THREE YEARS:
<TABLE>
<CAPTION>
Votes For Votes Withheld
---------- --------------
<S> <C> <C>
Benedict A. Itri 44,810,098 1,188,057
B. Allen Lay 44,784,582 1,213,573
</TABLE>
TO APPROVE THE AMENDMENTS TO THE 1993 STOCK OPTION/STOCK ISSUANCE PLAN:
<TABLE>
<CAPTION>
For Against Abstain
---------- ---------- -------
<S> <C> <C>
33,354,629 12,188,977 454,549
</TABLE>
TO APPROVE THE SELECTION OF DELOITTE & TOUCHE LLP AS THE COMPANY'S
INDEPENDENT AUDITOR FOR THE FISCAL YEAR ENDING DECEMBER 1998:
<TABLE>
<CAPTION>
For Against Abstain
---------- ---------- -------
<S> <C> <C>
45,786,761 101,870 109,524
</TABLE>
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits:
27.1 Financial Data Schedule
(B) Reports on Form 8-K
None.
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<PAGE> 25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the under
signed thereunto duly authorized.
PairGain Technologies, Inc.
-----------------------------------------
(Registrant)
Date: August 11, 1998 /s/ Charles W. McBrayer
--------------- -----------------------------------------
Charles W. McBrayer
Senior Vice President,
Chief Financial Officer and Secretary
(Principal Financial Officer)
Date: August 11, 1998 /s/ Robert R. Price
--------------- ----------------------------------------
Robert R. Price
Vice President and Corporate Controller
(Principal Accounting Officer)
25
<PAGE> 26
EXHIBIT INDEX
27.1 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 119,414
<SECURITIES> 78,917
<RECEIVABLES> 33,351
<ALLOWANCES> 0
<INVENTORY> 40,607
<CURRENT-ASSETS> 292,602
<PP&E> 35,082
<DEPRECIATION> 18,642
<TOTAL-ASSETS> 312,425
<CURRENT-LIABILITIES> 44,828
<BONDS> 0
0
0
<COMMON> 35
<OTHER-SE> 267,562
<TOTAL-LIABILITY-AND-EQUITY> 312,425
<SALES> 142,012
<TOTAL-REVENUES> 146,035
<CGS> 71,867
<TOTAL-COSTS> 71,867
<OTHER-EXPENSES> 40,701
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (4,192)
<INCOME-PRETAX> 37,659
<INCOME-TAX> 13,745
<INCOME-CONTINUING> 23,914
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 23,914
<EPS-PRIMARY> 0.34
<EPS-DILUTED> 0.32
</TABLE>
